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David Liabson“A lot of this stuff is wisdom our grandparents had, which we have managed to lose along the way. If you asked my grandmother if people would be more likely to save if you enrolled them or left them to their own devices, I think she would say automatic enrolment would make them save more. How that common sense got lost … I don’t really understand.” – David Laibson


 

Canadians are increasingly being reminded of the importance of saving for retirement. Yet, despite such efforts, savings remain dismally low, driving what pension experts are calling a looming crisis of inadequate retirement income.
The verdict seems to be in that left to their own devices, Canadians won’t voluntarily put money aside for retirement. Certainly immediate demands on income, including debt servicing, vacations, bills, and other day-to-day spending priorities, prevent Canadians from saving, but according to David Laibson, a professor of economics at Harvard, the answer is much more basic: it’s not in our nature to plan for tomorrow.

“We are pretty focused on what is happening to us right now and we are not necessarily thinking about what’s going to happen next week, year or decade,” he offered during a recent conversation with ARIA. “The root cause (of not saving) is that we are naturally prone to giving priority to the present, and to thereby diminish the future.”

It’s not that people can’t or won’t save for the future, but they need some assistance in that direction, he continued, pointing to the success of mandatory participation, auto enrolment and auto escalation as measures that are effective in the creation of retirement income.
“If you force me to, I’ll try to think about my retirement … but it doesn’t come naturally. What does come naturally is satisfying that itch for instance gratification – and that means not reading the mutual fund prospectus right now, but rather watching the hockey game.
“And it’s all of those moments in our lives when we prioritize the present and enjoy ourselves in the moment that lead us to slowly mortgage our future, so that 40 years later we are trying to retire with woefully inadequate savings.”
The professor was in Toronto recently for the Second National Summit on Pension Reform, addressing an audience of pension experts and policymakers on how people might be moved to save for retirement, against, it seems, their basic instincts. A behavioural scientist and a leading proponent of the nudge principle, Laibson said people and companies could be guided towards a particular outcome if they see the benefits, as well as the perils of not doing so.
A nudge, he explained, is different from compelling action, as in mandating participation in a retirement plan. For instance, American companies with 401(k)-style defined-contribution schemes were warned that they had a fiduciary duty to serve their members well, and that they could be liable if they didn’t, Laibson continued.
“The government didn’t compel American businesses to find low-cost mutual funds for their DC plans, but the threat of lawsuits worked very well, and in the span of 10 years fees fell in half for large employers.”
Requiring employers to participate in some type of retirement plan, as with the United Kingdom’s National Employment Savings Trust (NEST), New Zealand’s KiwiSaver, and Quebec’s new Voluntary Retirement Savings Plan (VRSP), is more of a directive than a nudge, said Laibson, but one he’d like to see expanded, saying “this is an area where we shouldn’t be terrified of stepping beyond nudges and actually engaging in requirements to facilitate retirement readiness.
“Every worker should have access to a plan that was either built for them by their employer or one that is provided by some other entity, but it works though payroll deduction and has all the important features of a workplace plan.”
To be effective, a retirement plan, or pension, should also involve auto enrolment at a healthy default rate of “more than five per cent,” or if not auto escalation to get savers to that range and beyond, the professor told ARIA.
Auto enrolment, he said, is one of the leading examples of behavioural economics. When people have to opt out instead of in, data shows that most don’t do anything, and stay with their plan, building retirement income. It may only take 15 minutes to sign up for a plan, but evidence suggests that is 15 minutes too many for most people, related Laibson.
“Even though tens of thousands of dollars are at stake, the 15-minute enrolment process makes a big difference. It acts as a barrier and stops a lot of people from joining their plan, or at least joining it quickly.”
Laibson said that even though there is more discussion and awareness of retirement issues, particularly the lack of adequate retirement income and the economic and social problems that will cause society, policy action is still lagging, especially in the United States. The last real change in pension legislation there, he explained, was the 2006 Pension Protection Act, and “all that basically did was to officially endorse automaticity in 401(k) plans … and by that I mean basically institutionalizing auto enrolment and escalation.
“But it didn’t drastically alter the DC retirement system – it really just nipped around the edges,” unlike more dramatic changes seen in, for instance, Australia’s superannuation system where compulsory savings are moving to 12 per cent of income, and the new Ontario Retirement Pension Plan (ORPP).
“The U.S. is constantly talking about the problems of savings inadequacy, but the 401(k) … is little changed since its inception.”
A change he would like to see introduced is one that would add a liquid savings fund to an illiquid retirement plan, to establish a kind of rainy-day source of income people could access in times of immediate need. He called Canada an “interesting hybrid because its workplace plans are illiquid, they do not allow leakage, but RRSPs do permit leakage,” giving the country a “kind of split personality on this issue” as most other countries don’t allow easy access to retirement savings.
“Only in the U.S. and the RRSPs of Canada do you see accounts where even without a good excuse, you can take the money and run,” he said, adding that Canada’s RRSPs are even more liquid than the American 401(k) system, which levies a 10 per cent penalty on sums removed before the age of 59.5. In Canada, of course, the only ‘penalty’ is deferred tax.
For that other liquid component of savings, Laibson said he likes another Canadian model: the Tax Free Savings Account (TFSA) that allows money to be withdrawn without penalty and without paying tax on growth. He envisions a model like that as part of a retirement plan.

“I’d like to see one account as your occupational pension, locked up until retirement, and the other something like the TFSA, with 10 per cent of your salary into the illiquid pension, and ten per cent to a liquid fund like a TFSA, and available when needed.”

When it comes to the nudge principle and behavioural science, much of it, said Laibson, is basic common sense that has been forgotten over the course of time.
“A lot of this stuff is wisdom our grandparents had, which we have managed to lose along the way. If you asked my grandmother if people would be more likely to save if you enrolled them or left them to their own devices, I think she would say automatic enrolment would make them save more.
“How that common sense got lost … I don’t really understand.”

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